Edited version of private ruling

Authorisation Number: 1011600035713

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Ruling

Subject: CGT - small business 15-year exemption

Question

Will the small business 15-year exemption in section 152-105 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to allow the legal personal representative (LPR) of the deceased individual to disregard all capital gains from the sale of the commercial property?

Answer: No, it will only apply to the interest acquired by the deceased pre-CGT.

This ruling applies for the following period:

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The commercial property was purchased by the deceased with their late spouse as joint tenants prior to 1985. The deceased's late spouse died in 1994.

Company A (the company) operated a business from the property from the date of purchase until 1995. The deceased and the spouse were the only shareholders and directors of the company. Each shareholder held 50% of the shares in the company. During this tenancy, the property was held solely for the business use of the company.

The deceased passed away in 2009. The taxpayer was more than 55 years old at the time of their death.

The deceased's estate was worth less than $6 million. They had no affiliates or connected entities at the time of death.

The rulee is the executor of the estate.

The property was sold at auction in the 2010-2011 income year. Settlement occurred in the same year.

In 1995, at the time of ceasing the tenancy of the property, Company A had sold the business. From this time until settlement occurred on the sale of the property in 2010-11, the acquirer of the business rented the property from the deceased.

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 152-105

Income Tax Assessment Act 1997 - subsection 104-10(1)

Income Tax Assessment Act 1997 - subsection 128-15(2)

Income Tax Assessment Act 1997 - section 128-50

Income Tax Assessment Act 1997 - Division 152

Income Tax Assessment Act 1997 - Subdivision 152B

Income Tax Assessment Act 1997 - subsection 328-110(1)

Income Tax Assessment Act 1997 - section 152-35

Income Tax Assessment Act 1997 - paragraph 152-10(1)(d)

Detailed reasoning

Did a CGT event happen in the income year?

The most common CGT event, CGT event A1 occurs when you dispose of an asset to another entity. The time of the event is when you enter into the contract for disposal or if there is no contract - when the change of ownership occurs.

You, as the legal personal representative (LPR) of the estate entered a contract to dispose of the property, triggering CGT event A1 (section 104-10(1) of the ITAA 1997).

As the deceased acquired the property as a joint tenant with their late spouse, over time they acquired two interests in the property; a 50% interest when they originally acquired the property and a 50% interest from the spouse upon their death in 1994.

You as the LPR acquired the property. Each of the two interests are considered to be separate CGT assets and must be dealt with separately. As the first 50% interest was a pre-CGT asset, you are taken to have acquired that asset on the day the deceased died (see subsection (128-15(2)). The second CGT asset is the 50% interest that the deceased acquired upon the death of the spouse (joint tenant), which they were taken to acquire on the day the spouse died (section 128-50).

Where an asset was acquired by the deceased prior to 20 September 1985, the first element of the cost base and reduced cost base of the asset in the hands of the LPR is the market value of the asset on the day the person died.

Where an asset was acquired by the deceased after 20 September 1985, the first element of the cost base and reduced cost base of the asset in the hands of the LPR is the deceased's cost base or reduced cost base on the day the person died.

Does an exemption apply?

Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the capital gains tax (CGT) concessions available for small business. These concessions are discussed in the Advanced guide to capital gains tax concessions for small business 2008-09 (NAT 3359).

A legal personal representative may be eligible for the concessions if a capital gain is made on an asset within two years of a person's death, if that asset is or was part of that individual's estate.

The LPR is taken to have acquired the assets on the date of death. Generally the cost base of the assets is transferred to the assets in the hands of the LPR, beneficiary or joint tenant (however market value is used if the deceased acquired the assets before 20 September 1985.)

In effect, with the disregarding any capital gain upon death and transferring the cost base upon death of the asset owner, any unrealised capital gain is deferred until a later sale of the asset by the LPR.

The LPR of the deceased estate will be eligible for the small business CGT concessions where:

· the asset is disposed of within two years of the date of death, and

· the asset would have qualified for the small business CGT concessions if the deceased had disposed of the asset immediately before their death.

In your case, the two CGT assets were disposed of within two years of the date of the deceased's death.

Would the deceased have qualified for the concessions prior to death?

The small business 15-year exemption is one of the four concessions available. This concession provides a total exemption of a capital gain if you have continuously owned the CGT asset for at least 15 years and the relevant individual is aged 55 or over and retiring, or is permanently incapacitated.

With regard to death and the 15-year exemption, the LPR will be eligible for the exemption to the same extent that the deceased would have been just prior to their death, except that:

· the CGT event does not need to be in connection with the retirement of the deceased

· the deceased needs to have been 55 or older immediately before their death, rather than at the time of the CGT event.

So even though your CGT event was not in connection with retirement, as the deceased was older than 55 on their death, it is necessary to consider whether they would have been entitled to the exemption just prior to their death.

The rules covering the small business 15-year exemption are contained in Subdivision 152-B of the ITAA 1997.

Conditions to be satisfied for 15-year exemption

Generally, an individual can disregard a capital gain from a CGT event happening to a CGT asset they have owned for at least 15 years if they:

· satisfy the basic conditions for the small business CGT concessions (the active asset test requires the asset to have been an active asset for at least 7 1/2 years of the whole period of ownership)

· continuously owned the CGT asset for the 15-year period ending just before the CGT event happened, and

· are at least 55 years old at the time of the CGT event and the event happens in connection with your retirement, or

· were permanently incapacitated at the time of the CGT event.

Did the deceased satisfy the basic conditions for the small business CGT concessions?

As step one, you must first satisfy one of the following:

· you are a small business entity

· you do not carry on business (other than as a partner) but your asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you (passively-held assets)

· you are a partner in a partnership that is a small business entity, and the CGT asset is:

o an interest in a partnership asset (partnership assets) or

o an asset you own that is not an interest in a partnership asset (partner's assets)

· you satisfy the maximum net asset value test.

Subsection 328-110(1) of the ITAA 1997 states that you are a small business entity for an income year (the current year) if:

(a) you carry on a *business in the current year; and

(b) one or both of the following applies:

(i) you carried on a business in the income year (the previous year) before the current year and your *aggregated turnover for the previous year was less than $2 million;

(ii) your aggregated turnover for the current year is likely to be less than $2 million.

The deceased did not carry on a business in the income year of their death. Therefore the requirement to be a small business entity is not satisfied.

As outlined in the second dot point, for passively held assets, the fact that you did not carry on a business does not preclude you from meeting the basic conditions if the asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you. However, the tenant of the deceased's property was not an affiliate, nor connected with them.

The deceased was not a partner in a partnership and therefore doesn't satisfy the third requirement.

You satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought. In considering whether the deceased would have passed the maximum net asset value test, you have advised that their estate was worth less than $6 million and that they had no affiliates or connected entities. On this basis, the test is satisfied and the first step of meeting the basic conditions is completed.

The second step in the basic conditions requires that the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997 (paragraph 152-10(1)(d)).

The active asset test is satisfied if:

· you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or

· you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7 ½ years during the test period.

The test period:

· begins when you acquired the asset, and

· ends at the earlier of:

o the CGT event, and

o if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows) - when the business ceased.

We must consider then whether the deceased would have satisfied the active asset test just prior to their death. The two CGT assets which constitute the property have the following characteristics:

To satisfy the active asset test then, as both interests have been held for more than 15 years, the assets need to have been active assets for a total of at least 7 ½ years each, during each ownership period.

A tangible CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you.

The advanced guide to CGT small business concessions provides that you control (and hence are connected with) a company if you beneficially own equity interests in the company that give at least 40% of the voting power in the company. The deceased was connected to the company during the period in which the property was used in its business. Therefore the assets were capable of being active assets for the period of the company's tenancy.

The first interest in the property was an active asset for a period of more than 7½ years. The second interest was only held by the deceased from 1994, when they were taken to acquire it, until 1995, a period of less than 7½ years.

Although both interests in the property satisfy step 1 of the basic conditions for the small business CGT concessions, only the first interest satisfies step 2, the active asset test. The second interest does not satisfy the active asset test. In order to determine whether the first interest qualifies for the 15-year exemption it is necessary to consider the conditions specific to that exemption.

Does the 15-year exemption apply?

The conditions to be satisfied for the 15-year exemption were discussed above and relevant to your role as the LPR include satisfying the basic conditions for relief and continuously owning the asset for 15 years, both as if the CGT event had occurred just prior to the deceased's death.

The CGT asset representing the first interest (acquired by the deceased pre-CGT) meets these criteria and hence the exemption will apply to any capital gain resulting from its disposal. The CGT asset representing the second interest (acquired by the deceased on the death of a joint tenant) does not satisfy the basic conditions for relief and hence none of the small business CGT concessions apply in respect of the capital gain you made on disposal of this CGT asset.